Multi-Component Systems Pricing: Rational Inattention and Downward Rigidities

Abstract

We examine how retailers discount the prices of product systems versus their constituent components. The topic is important because such systems are ubiquitous in our daily lives. In particular, many high-tech markets revolve around complex multi-component systems – e.g. a camera system consists of a camera body, a lens, a flash, and other components; a computer system consists of a central processing unit, a monitor, a keyboard, a mouse, etc. An important structural feature characterizing different systems markets is the degree of component interoperability. This affects the range of systems and component products available for sale and the possibilities of inter-brand mixing and matching of components within a system. We explain how these differences influence price discounts which are a widely used retail tactic to generate customer attention, drive store traffic and boost sales. In some markets, retailers discount system prices more than component prices, while in other markets, retailers discount component prices more than system prices. This relative price discounting of systems versus components hinges on whether the systems markets are loosely or tightly coupled.

In loosely coupled systems markets, consumers can choose from an array of diverse components (and brands) to include within a system leading to a high degree of mix and match (e.g. computers). In tightly coupled systems markets, in contrast, the components are often pre-combined as a complete system for the consumer, and there is far less choice of mixing and matching of components and brands (e.g. cameras). Critically, this distinction leads to different levels of consumer familiarity and knowledge of prices within each type of systems market and to differing degrees of effort needed on the part of consumers to attend to price changes and reassess their consumption choices. This underlies differences in consumers’ rational inattention to price changes across different systems markets. We contend these differing degrees of consumer inattention give rise to different patterns of downwards price rigidity across different systems markets by influencing the desired price cuts.

We find empirical evidence consistent with our ideas by examining price cuts in systems and components in an e-commerce context using a dataset consisting of 669,557 daily price listings for 1,052 different high-end cameras and computers from 102 online vendors. Using a second dataset comprising number of webpage visits, we also find our predicted pricing behavior is aligned with greater consumer attention for the firm.

Our key findings suggest that managers interested in building attention and market share should use smaller price discounts for systems (than for components) in tightly coupled markets like cameras. On the other hand, they should use larger price discounts for systems (than for components) in loosely coupled markets like computers.

To the best of our knowledge, this is the first paper to examine price reductions in multi-component systems markets. Our conceptual framework has implications worthy of further investigation in the areas of store merchandising, advertising and inventory management strategies in these markets. Such further studies would help bring research attention more in line with the importance of the topic.

Keywords: Rational Inattention, Systems, Components, Pricing, Price Rigidity, Price Reductions, E-Commerce

JEL Classification: D11, D12, D21, D22, D80, D83, E12, E31, L11, L16, L22, L81, M21, M31